Wisest of the crowds

The National Association of Realtors reported that their “Pending Home Sales Index” for July fell to its lowest level since the post Sept. 11, 2001 period as a result of tightening credit for Jumbo mortgage loans (loans over $417,000).

So what is this index? Directly from the NAR release:

“The Pending Home Sales Index is based on a large national sample, typically representing about 20 percent of transactions for existing-home sales. In developing the model for the index, it was demonstrated that the level of monthly sales-contract activity from 2001 through 2004 parallels the level of closed existing-home sales in the following two months. “

It seems that Three Stooges of the mortgage ecosystem, lenders (Curly), Wall Street mortgage underwriters (Moe), and mortgage buyers (Larry) all woke up after a night of drinking and decided never again (well, at least for a few weeks!) ! These Jumbo loans are NOT purchased by the quasi-government agencies Fannie Mae or Freddie Mac whose job it is to purchase loans from lenders so that lenders have the funds to make more loans - a mechanism to facilitate home ownership for average and lower income home buyers. Jumbo loans do not qualify so they must be either held by lenders or sold to investors via wall street. Since Fannie and Freddie have continued to support loans at the low-end while the high-end has lost free market support, Jumbo’s have shut down for the minority and have gotten MUCH more expensive for the majority. Not surprisingly, the Western part of the US, which has the highest home prices and presumably the most Jumbo loans, got hit hardest being down a whopping 20.8% to 82.3 versus 89.9 nationally.

Will this last? No way. This is a temporary disruption as people reorient their perspective to risk. Will the cost of jumbo’s (as a spread to treasury securities) increase? You can bet on it!

A couple of things I read this weekend are reinforcing something that I have been thinking about the contrasts of old-school business models and (the promise) of new school businesses. I don’t want to quibble about who is “old” and who is “new” but I guess the test is this: “Do you make a truthful promise to your customer?” Take at a look at theses facts, as an example, below:

- 50% of sub-prime borrowers could have qualified for prime rates, according to Fannie Mae

- “Yield Service Premiums” (kickbacks from lenders to mortgage brokers) are present in 85-90% of sub-prime loans.

- US Dept of Housing and Development estimates that 1 in 9 middle income and 1 in 14 upper income families have sub-primes

Are you kidding? As my kids would say “Sheezamageezza!”

This is old school businesses doing its thing of false promises (of their product or service) and lies (not disclosing dangers or conflicts of interest). Someone posing as an “agent” to a mortgage consumer “advises” that a specific product is “best” and the naive consumer accepts this as fact. Even corroboration with another mortgage broker may not yield substantially better terms because, well, the incentives are the same. The “agent” can sell 6.5% loan and make $3,000 or the 9.5% loan and make $15,000. Easy choice for the “agent”.

The issue is this: consumers are directly or implicitly promised one thing and given another. Bait and switch. Unfortunately, false promises are devastating people everywhere - like in the in sub-prime loan sector. Sadly this isn’t new - this is how business has been done forever and this still happens everyday. Think about all those commercials for processed food claiming to be healthy. This cereal or that snack bar. What do you think when you see this?

The company’s website says “symbols of quality, great taste, and nutrition”. Yet if you look into the ingredients you will see:

Its all crap yet somehow people trust that Quaker is a trusted source of nutrition. The brand promise is improved health and the delivery is poor health. The mortgage broker category promise is best rates and the delivery is, for some, the worst rates. False promises and lies - everywhere.

The business people I meet everyday don’t conspire against consumers but rather are reacting to and responding to duplicitous commercial behavior. This is a market response that will win - eventually.

Interestingly there are others looking at this as well. One the one side are those, like Greg Swann in this wordy post, that believe that regulation should be replaced with personal responsibility and free market solutions as it relates to, for example, real estate agents.

On the other hand, there are those like Elizabeth Warren, a Professor of Law at Harvard Law School, that make an argument for more regulation in a post entitled “Unsafe at Any Rate” referencing the dangers of various consumer financial products and services.

Swann makes the argument that there should be no licensing requirements for real estate agents and that the industry is using regulations to benefit themselves rather than consumers. I agree that the there is a false promise made to consumers with the agent “licensing” scheme but am undecided if removing licensing makes sense for the very same reason that the sub-prime market is a mess - consumer ignorance and bad actors (although not necessarily illegal actors) yield substantial problems. Matters of health and safety are basically the governments job and so just where the lines of safety end is very debatable. Should financial safety be elevated to bodily safety?

Warren thinks so. Her argument is basically that consumers are subjected to too much complexity - complexity meant to trick consumers or keep them ignorant. For example, most people need not scrutinize consumer products at an engineering level because the government sets saftey guidelines and requires clear saftey disclosures. Yet for financial products it is essentially caveat emptor. Consumers must do the equivelant of engineering (and law) to understand the products they are buying and the risks that they are taking. Adding conflicts of interest, common in the mortgage brokerage and payday businesses, makes consumers that much more vulnerable.

The free market rebuttal to Warren is that a market solution will evetually emerge, which I agree with, but the issue really is how many people must suffer in the interim? How many false promises and lies must people endure before a market solution kicks in? What is an acceptable casualty rate?

No not what you are thinking - not social, ethnic, or racial discrimination. Redfin discriminates on price. PRICE! The 60 minutes piece was a yawn for me personally but it does give Americans the right to start to push back. See the posts and comments at TechCrunch, Redfin, Inman, BloodHound for an early read. Whether it becomes a consumer zeitgeist or fades will be seen but the open question is this: will price variation become mainstream in american residential real estate?

There is an old economic idea called price discrimination that is popular with every micro-econ 101 student, and their professors, that says you reach more customers and make more money by offering variation in pricing. Its sort of definitional for anyone who believes in supply and demand. It works like this: when you go to see a baseball game, there are a 100 variations in pricing to meet everyones needs and to tap into every possible cross section of demand. For example, there are ticket prices for corporations who entertain in luxury boxes and ticket prices for those who mostly prefer a beer and some sun in the bleechers. Ticket prices for season holders and ticket prices for last minute shoppers. In short, EVERYONE can have their demand met for baseball. A small example with the mighty SF Giants here.

What would happen if every ticket was the same price? Mayhem and lost profits. Some people willing to pay more for MLB tickets will transfer their money to an underground marketplace that will use price discovery to allocate tickets. Meanwhile, people at lower price points will be shut out resulting in further lost revenues to MLB. Thats why we have pricing variation. Its better for everyone because everyone gets an allocation and the business folks maximize their revenues.
People might argue that the price variation exists is in the underlying house price and not in the intermediary execution price (brokers & agents). If that were true, then why did trading volume in financial markets explode when electronic execution came into acceptance? (For a slightly more technical explanation {very slightly!}, see my earlier post here).

Redfin discriminates. So do I. It makes sense and it is better for everyone. Many people have commented that Redfin basically passes their work load to external agents to facilitate their transactions and to make their business model work. I can certainly see how that might play out. But if the consumer is footing the work load “bill”, don’t they deserve to get a rebate? Don’t consumers deserve the right to choose their level of service? In the end I believe that consumers will still depend on full service agents because housing is complicated and its something we do rarely. But by offering price variation, we get to grow the pie. Anyone else out there a discriminator? Anyone else want to make more money?

The National Association of Realtors reported existing homes sales today (the press release). The data was scary and probably indicated the first quarter activity was a knee-jerk reaction by consumers who were sidelined the previous quarter. Of course this didn’t stop the NAR from spinning it as Matt Carter at InmanBlog noted in his excellent post, “Again with the weather”.

Here are the facts:

- Nationally, sales declined 8.4% versus last month and is down 11.3% versus last year.
- The West was hit hardest, being down 9.1% versus last month and down a whopping 16.7% versus last year.

- Median prices were up 1.6% nationally but down 1.8% in the west versus last month

- Inventory declined 60k units (1.5%) to 3.75 million units but because of faster declining sales, the number of months of supply actually increased to 7.3 from 6.8 a month earlier.
- This monthly decline was the largest since 1989 according to the Associated Press via MSNBC and the NYT

What does this all mean? Probably just that there was a “dead cat bounce” in interest in the first quarter of 2007 after the unbelievably slow fourth quarter of 2006. This happens all the time in financial markets where people attempt to bottom pick a falling market resulting in a series of rapid, but ultimately unsustainable, bounces. If this is in fact a dead cat bounce, look for prices to go substantially lower. From my experience as a trader, it will only be when people loose hope that a bottoms in prices gets set. Did you know that more people lost money in the 1929 crash buying stocks 50% below their peak?
Having said all this, markets are hyper-local and what’s true generally can be completely untrue for your neighborhood or street. If you live where new supply is negligible and high-paying jobs abundant and secure, don’t sweat it. If you live in a place where new construction in plentiful and excessive credit rampant, look out (sorry Florida)!

Side note: My-Currency markets are predicting lower prices in many san francisco zip codes over the next 3-6 months. An example for 94117 (Haight, Alamo, Ashbury Heights, Cole Valley)